Mastering Inventory Reconciliation: A Step-by-Step Guide
Running your own business is exciting, and that’s partly because there’s always something new to learn. You’ve got an excellent product, a solid customer base, and enough revenue to sustain your growth, but have you considered the importance of inventory management best practices?
Good inventory management is essential for minimizing carrying costs, preventing items from going out of stock, and making wise financial decisions. If you don't know how much inventory you have on hand, it's tough to figure out when to order new stock or replenish your supply of raw materials.
To prevent financial discrepancies and ensure the overall health of your business, it's important to reconcile inventory regularly. This guide explains what inventory reconciliation is, walks you through the steps, and provides tips for overcoming common challenges.
Understanding Inventory Reconciliation
Inventory reconciliation is simply the process of comparing inventory records with what you have on hand. Any product-based business can benefit from inventory reconciliation, but it's especially helpful in manufacturing and production environments.
Inventory consists of finished goods, work in progress, and raw materials. Each category has a different purpose, so you have to treat them differently.
Finished Goods
Finished goods are items that have been through the entire production process and are ready for sale. If you know how many finished goods you have on hand, it's easier to answer these questions:
How many items should we order from each supplier?
Do we need to change our production schedule to account for increased or decreased demand?
Will we have enough stock on hand to meet seasonal demand for our most popular products?
When should we place our next order to avoid going out of stock on popular items?
Maintaining an accurate count of finished goods also helps with inventory valuation, or the process of determining the value of your unsold stock. To ensure an accurate reconciliation, take these factors into account:
Count accuracy: The first step is to count ready-to-sell items stored in your warehouse and other designated areas.
Sales and returns: You need some way to account for unshipped orders and unprocessed returned goods. For example, if a customer returns an unopened bottle of cleaning solution to your store, the bottle becomes part of your finished goods inventory as soon as you process the refund.
Valuation: Finished goods should be valued at their full production cost. This includes direct labor, direct materials, and allocated overhead. Don't short yourself by accounting only for labor and materials.
Documentation review: Ensure all items leaving the production line are documented as finished goods.
Work in Progress
Work-in-progress inventory consists of items that have started the production process but aren't quite finished. Reconciling your WIP inventory is essential for making production decisions.
The reconciliation process is a little more complex for WIP inventory, as you're dealing with items at multiple stages of completion. You also need to track raw materials that have been allocated to production but haven't found their way into finished goods yet. To maintain an accurate count, you must track materials through each production stage and allocate your costs based on the stage of completion.
Raw Materials
Raw materials are the basic inputs required for production. You can't produce finished goods without these materials, making them essential for your company's success.
Raw materials reconciliation makes it easier to determine when to order from your suppliers and how much you should order each time. Good inventory management also prevents perishable materials from going to waste.
Reconciling your inventory affects the following aspects of operations:
Accuracy of financial statements: Performing regular inventory counts makes it easier to create accurate financial statements.
Supply chain management: As noted above, inventory reconciliation optimizes supply chain operations by increasing forecasting accuracy.
Performance analysis: Sales velocity is one of the most important metrics for CPG brands. Inventory reconciliation makes it easier to assess the performance of each product line. With proper planning, you can focus on your hero products and eliminate the underperformers.
Customer satisfaction: Inventory reconciliation also enhances customer satisfaction by preventing delayed shipments and back orders.
How to Perform Inventory Reconciliation
When you reconcile inventory, you can do a full inventory count or a cycle count. A full count includes all stock and happens just once or twice per year. In contrast, a cycle count involves counting small amounts of inventory at regular intervals.
To increase accuracy and reduce the time it takes to complete the reconciliation process, consider using handheld scanners, RFID tags, and other forms of technology. It's possible to count everything by hand, but manual counts are extremely time-consuming and prone to human error.
When you're ready to get started, follow these steps:
Create a list of items to count. Your list should include the quantity of each item. Otherwise, you won't be able to determine if your physical count matches your inventory records.
Pick a date. The date you choose should have as little impact on your operations as possible. For example, if your business hours run Monday through Friday, consider doing inventory on a Saturday to prevent interruptions.
Decide whether to hire temporary staff or use your current employees. Depending on how much your employees earn, it may be more cost-effective to bring in contractors.
Train your employees, if needed. Schedule the training session as close to the inventory count as possible, or staff members may forget what they learned.
Verify that you have enough equipment and supplies on hand. If you plan to do a manual count, you'll need count tags, pencils, clipboards, and other items. If you plan to incorporate technology into your reconciliation process, you'll need handheld scanners and other equipment.
Mark items that shouldn't be counted.
Print a final list of items to count. Before you print this list, freeze your inventory system so employees can't make changes. Otherwise, your final list is likely to have inaccuracies.
Assign each employee to a specific section of the warehouse or store. Provide an inventory map and a copy of your final item list.
Direct employees to count the items in their assigned sections.
Have managers enter the data into your inventory system.
Compare the new counts with the previous counts to identify discrepancies.
Investigate each discrepancy and adjust the inventory count as needed.
Common Challenges and Solutions in Inventory Reconciliation
Human error, theft, and discrepancies between your physical inventory and your inventory records are some of the most common challenges encountered during inventory reconciliation. Fortunately, there are ways to minimize these challenges.
Human Error
One way to combat human error is to train staff members thoroughly. Walk them through the process of counting items and recording the results. If you plan to use scanners or other devices, train staff to use each device correctly. It's also important to simplify the process as much as possible. The more complex the process, the more likely it is that your staff will make errors.
Theft
If you uncover a significant amount of theft, review your company's security policies to determine if you need to make changes. Depending on what type of business you run, you may need to hire additional loss-prevention staff or put some of your most expensive products in locked cases.
Consider signing up for a monitored security service or installing additional security cameras on your company's premises. Extra security features serve as an effective deterrent.
Discrepancies
Your physical counts may not match your records for the following reasons:
Warehouse employees didn't scan incoming shipments correctly.
Employees in your shipping department didn't scan an outgoing shipment before loading it.
Staff didn't scan returned items back into your finished goods inventory.
Your company is using outdated technology.
Someone misplaced a finished good, a work in progress, or a package of raw materials.
To prevent discrepancies, provide ongoing training to ensure every employee understands what to do with finished goods, work in progress, and raw materials under different circumstances. For example, employees responsible for accepting returns need to know how to add returned items back to your company's finished goods inventory.
It's also helpful to use some of the reports available in QuickBooks Online:
Inventory valuation summary: Your inventory valuation summary tells you how many of each item you have on hand, along with its value and average cost.
Inventory valuation detail: This report provides detailed transaction information, making it easier to understand how each transaction affects quantity on hand, value, and cost.
Physical inventory worksheet: The physical inventory worksheet lists each item and gives you space to enter physical counts. Once you complete the worksheet, it's easier to compare your physical counts with the counts stored in QuickBooks Online.
Emphasizing the Importance of Inventory Reconciliation
It's no secret that effective inventory management is essential for a company's success. If you aren't already performing regular inventory reconciliations, it's time to start. Increase the accuracy of your inventory records by adopting a new reconciliation process right away.
Balanced Business Group takes the guesswork out of accounting, finance, and other critical functions, giving you more time to focus on your business. Discover how to streamline operations and boost your profit margin by reading some of our other articles or contacting us to inquire about personalized services.
